4

Seed Stage Investments and the Well

Slicing Pie allocates slices of the pie when contributions to the company are put at risk. When you spend an hour working on company affairs, for instance, you are taking a risk that you will never get paid for your contribution. The amount of that risk is equal to the amount you would have otherwise been paid for the same contribution to a company that had the money to pay you. This is the fair market value of your time. All contributions have a fair market value and this serves as a basis for the calculations of slices in the pie (also known as theoretical value). In the Slicing Pie model, non-cash contributions (like time) use a 2x multiplier and cash contributions (like cash) use a 4x multipler. (If you have read Slicing Pie, this should all make sense).

Tracking cash contributions can be trickier. Traditionally, when a cash investment is made the investor gets a chunk of equity based on the current post-money valuation of the company. If no valuation is available (which is common in early-stage companies), investors accept a convertible loan agreement which means that their loan becomes equity if and when a valuation is agreed upon by larger investors.

In the Slicing Pie model, slices are granted when risk is taken. When an investor puts in money it’s not necessarily at risk if it’s simply sitting in the company account. The money is not at risk, therefore, until it is spent.

The “Well” is a model for tracking the investment of cash and converting it to slices. Using the model, cash investments are accepted as basic loans and the money is put into a corporate savings account or other secure account. When managers need cash to pay bills they transfer money from the Well into a checking account where it can be accessed. At this point, the money converts to slices at the 4x rate. At the same time, the balance of the loan reduces by that same amount.

If multiple investments are made into the Well, slices are allocated in proportion to ownership of the Well. For instance, if Mike invests $10,000 in the Well he gets no slices, just a loan agreement. The money goes into the corporate savings account. When the company manager takes $5,000 out of the savings account to pay bills, Mike receives 20,000 slices of the pie ($5,000 x 4) and his loan is reduced to $5,000. If Anne decides to invest $5,000 it is put in the savings account. Now the Well balance is back to $10,000, but Mike owns 50% and Anne owns 50%. The next month, when the manager withdraws $5,000, Mike gets half the slices and Anne gets the other half. So, they each get 10,000 slices ($2,500 x 4) this goes on until the funds in the Well are depleted.

The Well provides a mechanism to accept investment into a company using the Slicing Pie model so it will be on hand for future use. Investors get slices when and if the funds are used. This is fair and it properly aligns the interests of the managers and investors. Knowing that withdrawals from the Well convert to slices at the 4x rate makes managers think twice about how they are spending money. Careful financial management is a good thing!

Below is a short video showing how the Well plays out using the Pie Slicer application.

  • Boggle

    Where does the 4X for cash and 2X for work time come from?

  • pc1985

    The entire book is bunk based solely on the arbitrary 4x cash/loan contribution measurement. It tilts the equity sharing absurdly, permanently in favor of VCs/lenders and away from grunts. All other formulas and models in the book become meaningless in the face of that. If there are no grunts, there will be no business, period. A grunt can build a business with little to no cash, might take a little longer, but cash can’t build a business. You need dedicated, hard-working founders or you have zilch. Switch it to 4x time vs 1x cash or 4x time and 2x cash, and then we’re talking.

    Picture a ‘grunt’ founder who has a ‘leader’ partner who makes a loan but does little to no work. The grunt is a capable entrepreneur but comes from a $50k a year job, so his time for the first year is doubled at $100k for the grunt fund, a year that consists of designing, implementing, and maintaining the entire business. The partner loans the business $200k, so he has $800k in the grunt fund, and now owns 89% of the equity for doing absolutely nothing, and contributing zero time or energy to the business! The grunt could continue to build a massive business by himself for 8 more years working for zero salary, and he would only own 50% at that point! If he actually needed a salary at some point, forget it, he’d never get over 20% even though he did everything. And that’s if the leader didn’t hire a manager employee and fire the grunt after building a company by himself. Complete joke of a system.

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